Charles Calomiris of Columbia University and Stephen Haber of Stanford University, co-authors of Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, talk with EconTalk host Russ Roberts about their book. The conversation focuses on how politics and economics interact to give some countries such as Canada a remarkably stable financial system while others such as the United States have a much less stable system. The two authors discuss the political forces that explain the persistence of seemingly bad financial regulation. The conversation includes a discussion of the financial crisis of 2008.

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0:33

Intro. [Recording date: February 5, 2014.] Russ: Welcome to this special edition of EconTalk, recorded in front of a live audience here at the Hoover Institution's Washington office.... Their book is Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, which is our topic for today's episode.... I want to start with the fundamental claim of the book: you reject the idea that bank crises or bad luck or a perfect storm of random events. Rather, you argue that banking crises and systems are fragile by design. Steve, what do you mean by that claim and what's the justification for it? GuestH: So the basic idea of the book is that banking systems are fragile by design because it is impossible to take politics out of bank regulation. And it's impossible to do so because there are inherent conflicts of interest between government and banking systems such that banks need governments and governments need banks. Those conflicts of interest basically boil down to three features. First, governments simultaneously regulate banks and borrow from banks. Second, governments simultaneously use their police power in order to enforce debt contracts on behalf of banks; but people who are being, let's say, forced out of their houses because they've defaulted on a mortgage are voters, and so when banking crises occur governments often have reasons to not enforce those debt contracts. Third, governments are in charge of liquidating failed banks. But the biggest group of creditors to a bank when a bank is liquidated are its depositors--who are voters. And so governments have incentives to change the rules of government deposit insurance for political ends--so often extend deposit insurance beyond its statutory limits. Because of those three basic inherent conflicts of interest, it's extremely difficult to remove politics from banking. Governments have, or parties inside the government have inherent reasons for wanting to use the banking system for their own ends, and at the same time, bankers need the government in order to do things like enforce debt contracts. There's no getting politics out. Russ: And financing wars--the book is a remarkable history of banking and the banking industry in 5 different countries and a credible work of scholarship and history combined with the political economy that we're talking about. Now, Charles, I want to talk about the game of bank bargains, which is a central concept in the book. Tell us what that is and how do you apply it? GuestC: The 'game of bank bargains', a phrase that we invented to describe the fact that the outcome of the rules of the game of banking reflects political alliances that are formed, between always involving the parties that are in charge of the government, and some other parties that ally together and form an alliance with the government to determine the rules of the game. The point is that in the game of bank bargains there is going to be a group of people who are in charge. And there are going to be a group of people often who are left out. And it won't be a big surprise to you that the people who are in charge will use their power in this game to take advantage of the people who are left out. Russ: Of course, they are not a monolithic group. They are fighting among themselves for their share. GuestC: In fact the key, and this is one insight that I think is important in the book--it is a little different from the way some political scientists think about some political struggles, where they tend to think it's struggles between political parties. One of the points that we make in the book is that the coalitions that have evolved, let's say in the U.S. history, to design the rules of the game of banking have often been bi-partisan. In fact, they purposely have structured themselves to be fairly immune to electoral partisan outcomes. And so it's just as you would expect. If you wanted to have a long-lived and valuable coalition, you would want it to be fairly robust to electoral outcomes. And so sometimes you get a very unlikely partnership, people who ideologically or culturally, sociologically, don't really see eye-to-eye at all, but find a convenience in being allies in a particular arrangement. Russ: Yeah. The way I think of it is: The Democrats and the Republicans are the same; they both like to give money to their friends. They just have different friends. But they have one friend in common, which is the financial sector. And they both tend to scratch that sector's back and get scratched back in return. Which is another way of-- GuestC: I agree with you, but I would go even farther to say that sometimes they might pretend to have different friends more than they really do. Russ: You want to give us an example? GuestC: Well, you know, we're going to I'm sure talk about the current U.S. crisis eventually. But one of the things I think is really interesting is that one of the contributors to the crisis was mortgage-subsidization policies in the United States. Russ: Encouragement to home ownership in all kinds of dimensions. GuestC: But encouraging home ownership precisely in a particular way, by creating subsidies for taking risk in a mortgage market. You can encourage home ownership in a lot of ways. Russ: Correct. GuestC: What's interesting is when we look at the last, let's say, 15 years or so of that policy, what we see is George H. W. Bush, followed by Bill Clinton, followed by George W. Bush, followed by Barack Obama. And even though you might think of it as people very different ideologically, they actually were part of a continuous thread of very similar kinds of policies from the standpoint of some of the issues that we're talking about. I would add to that, that [?] the unlikely coalition members that sort of sit underneath these bi-partisan agreements. In the case of the United States we had activist groups allied to bankers that were in the process of creating mega-banks, through the 1990s merger movement [?]. To the point that at Federal Reserve Board hearings about mergers, activists would show up--for example, from ACORN (Association of Community Organizations for Reform Now) and testify on behalf of the Bank of America merging with NationsBank. This is not the usual role that you would imagine an activist group taking vis-a-vis a bank merger. So you get these very unlikely partnerships which precisely because they straddle partisan lines were extremely durable and made it very hard for any party to deviate from the agreement. Russ: It's an interesting coalition because as you point out, there are a lot of voters in the discussion. Those are the homeowners, who are clearly a lot of those. But in general in democracies, large groups don't get treated particularly well. So I see it is--my somewhat cynical, perhaps realistic take, is that they were a vehicle to give cover to giving money to these much smaller and politically powerful groups--the realtors, the home-builders, and the banks who financed them through the political incentives that were inherent in the system. GuestC: Well, they got everybody who was part of that winning coalition in the game of bank bargains did quite well, thank you. So the total amount of subsidized credit that was contractually agreed as a quid pro quo for those activist groups to show up at the merger hearings, which is an understatement of the amount they actually received, was almost $870 billion over the period 1992-2007. So that's not chump change. Russ: We've gotten into the weeds here a little bit and I think we ought to do a little bit of clarifying. You are talking about the Community Reinvestment Act, which--I'm going to push back a little bit when we get to it in more detail, but we should just mention here that a lot of people who blame the Community Reinvestment Act for playing a role in the 2008 financial crisis get challenged by saying: Well, but that law was passed in 1977. But the teeth of the law really only took place in the early 1990s when it became the determinant of whether a bank could merge or not. And that's when it started to have an impact. How big that impact is, we'll talk about. But I just wanted to get that straight.

10:11

Russ: Let's go back in the history a little bit. And we'll start with the United States. I wish we had a 5 or 6 hour podcast; I know the audience do, too; but we don't. And I know you'd all like to stay for that. But we are going to not be able to cover all the aspects of the book. But let's start with the United States and going back into the history of the United States. You talk about the 19th century as a particular era of banking in the United States. Steve, tell us why the United States was so prone to crises. A lot of people, when they look back at the 19th century, they see it was bank run after crisis after failure. Why was the United States so unstable in that era. GuestH: So first let me say I'm appalled and shocked that we don't have 5 hours. I'd been counting on it. Second, to answer your more specific question, the United States in the 19th century has a banking structure unlike any other country on the planet. It has thousands of banks-- Russ: Thousands? GuestH: Thousands of banks. Russ: Tens of thousands, right? GuestH: By the early 20th century, tens of thousands. Which are, in most states, unable to open branches. So every bank--every bank which you would think of as a branch is a bank unto itself. That means that in the event of a bank run it's very hard to move funds from one branch to another because there aren't branches. It means you can't spread risk across regions--that you are tied to the local economy. And it meant that banks couldn't capture scale economies in administration, so the banks are very inefficient. Russ: All those things seem pretty obvious. Right? That they were inefficient, they are stuck with the local economy. Why-- GuestH: So, there's a political deal that's underneath this. And essentially, just like we were talking about the coalition between populists and bankers and mega-bankers in the 1990s and early 2000s, there's a coalition between small bankers and farmers in the 19th century. And what their concern is, is to get credit to small farmers. And small farmers are also opposed to big city people--that is, big city aristocrats. Especially bankers. And so you get an alliance of small bankers and farmers against big bankers. Most particularly and famously is the unraveling of the Bank of the United States--first in 1911, and then it gets re-founded because Central Government realizes that it needs a bank to prosecute wars. And then it gets unraveled again during the Jacksonian period--the Second Bank of the United States. And so, in order to make sure then that banks would not have to face competition in their markets, [?] years of bank regulation in most states, what happened in most states is they made it illegal for a foreign bank to branch into your state. Meaning a bank from Rhode Island couldn't branch into Massachusetts. They also made it illegal for a bank to open a branch. And so most states had laws, except themselves[?], that precluded branch banking. The point we make in the book, the takeaway is--I'm sure someone could write down an economic model in which this made sense. You can write down lots of models. That was a joke. But this is clearly a political arrangement. There is no efficiency or stability criterion by which you would do this. It did however work quite well for local unit bankers because they had captive local markets. Essentially they had local monopolies. And it worked well for relatively prosperous farmers in a particular community because they knew that that bank had to lend to them and nobody else, because the cost of gathering information at a distance in the 19th century--even up until the 1990s, most bank lending in the United States is local. Really until the computer revolution. So that created this sort of cozy arrangement, good for the local farmers, good for, in the North and in the Mid-west, good for unit bankers. Bad for anybody else who wanted access to credit, and bad for the system as a whole. Because about every decade there is a banking crisis. Russ: So it's hard to remember, in the world that we live in where agriculture is 2% of employment in the United States. In 1900 it's about 40%. So it's an important sector. The people who are the more important decision-makers in that sector are going to be politically powerful in their region. But as we go forward from the 19th century, really continually through the 20th century and starting at the end of the 19th, agriculture becomes less and less important as an economic factor. Why didn't that coalition unravel sooner? We have branch banking--came around I think 1970 or so. So Charles--it's a nice story, ex post, right? It's easy to tell a story after the fact. Why did it unravel and why did it not unravel sooner? GuestC: Well, I think first I want to emphasize how striking it is that it lasted for about 150 years. So, many things--there were lots of shocking things going on in the United States. The Civil War. Two World Wars. A Great Depression. A lot of banking crises during the late 19th and the early 20th century. Even the Savings and Loan Crisis in the 1980s, which finally contributed toward it's demise. But what's interesting is that over 150 years of turmoil and inefficiency, it persisted. Now part of the story is Federalism in the United States, because, starting from the very beginning, the states have authority over deciding what the rules of the game of engagement for banking were going to be within their states; and also they had the authority to restrict out-of-state banks from participating. So that meant that if you were in, let's say, Kansas or Illinois or many other such states, if the agricultural interests there wanted to maintain unit banking, they just had to win the battle at the state level. And so it was a lot easier for those agricultural interests to win the battle at the 50 state levels than it would have been if they had had to fight that battle on a centralized basis. And we make that argument sort of at length in the book, why that is, and contrast in particular one of the things that explains why the United States had such a hard time getting a nationwide branch banking system going was the decision-making about the law was at the level of the individual banks. So then, in the 1860s, we create the National Banking System. It sounds like something if Federal Government is going to do this, could have been a nationwide banking system, like the Second Bank of the United States were. But what happens is the culture[?] of the currency and Congress probably would have not let the Comptroller decide differently. If the Comptroller decided that national banks had to be unit banks-- Russ: A unit bank, meaning one building, basically. GuestC: Right. So national banks were the National Bank Out In The Middle of Nowhere. And that was it. Russ: What was national about it? GuestC: The charters were the same. They were operating under the same rules, under the same chartering authority, under the same supervisory authority. But they were cheese and chalk in terms of the business that they did because one is in a city, one is in the country. And they had, as Steve pointed out earlier, very particular risks, too. They couldn't diversify across regions. So the United States was--as everyone understood and was practically making fun of us. Canada especially, 'look at the ridiculous banking system these people have.' But it persisted because it was actually pretty challenging to create a nationwide branch banking movement in an environment of political decision-making that was so fragmented.

18:31

Russ: So, one of the reasons it doesn't unravel immediately, or earlier--and I'll let you take this, Steve--is the establishment of the Federal Reserve, which was--I think a lot of people think of the Fed, the Central Bank of the United States, as sort of the--well, bankers, they get greedy; people get greedy; they get out of control; they run amok; and then you need somebody to clean up the mess. Neglecting the fact that the mess was sort of baked in--I think you use that phrase--and the fact that there was this unit banking system. So the Fed politically was a way to mitigate some of the worst effects of this system and keep it going longer than it would have. Is that correct, Steve? GuestH: That is correct. What's interesting about the Fed is it has to be understood as a reaction to the Panic of 1907-1908, and there's a national monetary commission that is created to look into how to fix the banking system. One option they had--in fact they studied the banking system in other countries, including Mexico, which had branches of two of the largest banks who were allowed to branch nationwide. So they studied Canada, they studied Mexico, Germany. They were quite aware of what the other models were. And then they rejected all those models in favor of retaining unit banking, but propping it up by creating 12 Regional Fed Banks that could essentially lend to unit banks by increasing liquidity in times of crisis. Russ: Essentially a safety net for them. GuestH: Essentially a safety net for unit banking. And I'd point out: The same thing happens in the Great Depression, where I'm sure everybody remembers their high school textbook which talks about how the 'New Deal saved the banking system by creating deposit insurance and creating the Glass-Steagall Act. Russ: It's not in the textbook. GuestH: I helped my daughter study for the AP-United States history test. Russ: Did you do well on that exam, by the way? GuestH: I got a 4. Russ: I did not. When my daughter took the AP history exam, I panicked, because I thought, 'I'm getting a 2 here, and I'm going to hurt her chances.' I had a different perspective. GuestH: I usually did bad in English classes so if I helped my daughter write a paper for an English course she'd get a B-. So my daughter decided, 'My father doesn't know how to write.' Probably right. In any case, in the Great Depression, not only did my sort of forebears also get Bs in English, but the response was again to prop up the unit banking system. Russ: Realistically; history could have turned out very differently. They could have said this system is incredibly messed up. We had thousands of banks fail; we need a different system. And instead they said, let's choose this lever. GuestH: And in order to prevent the consolidation of banks, which is what would have happened in the absence of, for example deposit insurance and Regulation Q, which made it illegal to pay interest on checking accounts and kept interest to be paid on savings accounts. It's all done to discourage banks from competing with one another. Done to discourage people from moving their savings from one bank to another. And what I want to drive across here: again it was a, to come back to something Charlie said, there's the coalition of agrarian populists and unit bankers is what drives that decision. FDR (Franklin Delano Roosevelt) was against deposit insurance. Russ: When he was Governor of New York-- GuestH: And when he was running for President-- Russ: Explain why he was against it. It's very important to understand that. GuestH: Go ahead, Charlie. GuestC: When he was running for President in 1932 he said deposit insurance would make banks riskier because protected[?] banks would take excessive risks. Russ: He was onto something there. [?] GuestC: Well, of course. In insurance [?] we call that the moral hazard problem. When you insure someone against risk, they tend to take more risk. So he was--let Steve continue--he was definitely against it, as was the Federal Reserve, by the way. As was the Treasury Department. As was Carter Glass, who had been one of the architects of the Fed originally and was the architect of banking reform, some of the banking reforms, during the 1930s. But someone was in favor of it. GuestH: And so the someone is, Henry Steagall, who is a Congressman from Alabama and is chairing the House Banking Committee, and he is determined to protect the unit bankers. And he rams deposit insurance through at the last minute. And what's interesting about it is it's put in place as a temporary measure that was only supposed to affect very small deposits. And then a few years later it's logrolled and made far more expansive. Russ: Do we know anything about his personal life? Why was he a champion of unit banking? Why was he their friend? Do we know? GuestC: Well, there were some politicians going back--we'll call them the agrarian populist politicians. William Jennings Bryan, going back to the 19th century. Henry Steagall was--and Huey Long--were the politicians in the 1930s cut from that same cloth. Their constituents were--especially their most important supporters--landowners in environments that had small unit banks that were particularly shaky. So the thing, as Steve pointed out--if you have only small deposits protected that means you are going to have very big protection for small banks located in Alabama. But New York City banks--almost none of their deposits were protected. Because the protection was only on small deposits. So now you may be able to understand better why Henry Steagall liked Federal Deposit Insurance. Russ: He had a few friends, too. GuestC: But it was clearly a transferring mechanism from city banks to small country banks. So if you are an Alabama politician it looks pretty good. There were 150 attempts from 1884 until ultimately 1933 to bring the Federal deposit legislation forward, and they were all done by similar people under similar circumstances. They never got out of committee until finally in the 1930s.

25:00

Russ: So, why did this populist, agrarian coalition fall apart ultimately? GuestH: Well, there are a couple of pieces that I think we can bounce back and forth about this. One of them is it was inconsistent with technological changes that were occurring in the banking industry. You guys are too young--I remember the introduction of the first-- Russ: Which one of us? GuestH: No, the people out there in the audience. We're all the same--we all grew up in the days of disco. And you remember that the 1970s were famous both for disco and the invention of the networked ATM (Automated Teller Machine). So the networked ATM and the computer technology that goes with it allowed for two things. First, computer technology allowed bankers to assess borrowers at a distance. They weren't sealed into a local unit bank. But it also meant that banks could skirt the laws governing branching by simply opening up an ATM anywhere they could rent 6 square feet of space. Russ: A very small branch. GuestH: Yes. In fact, the unit banks took the big banks to court over this, claiming that the opening of a networked ATM violated the law. Those lawsuits went all the way to the Supreme Court, which finally in 1985 ruled that an ATM was not a branch bank. Second piece of this had to do with the fact that a system in which there are regulations governing the interest rates that banks can pay, Regulation Q--only works at a time when inflation is very low. And so, certainly in the 1950s and the early 1960s, the United States is characterized by very low inflation. Beginning in the later 1960s, especially through the 1970s, the government is starting to run big deficits to simultaneously prosecute the War on Poverty and the War in Vietnam. As inflation climbs up, interest rates paid on bank deposits become strongly negative; even Post-Modern English professors understand that under those circumstances, you should take your money out of a bank and move it into another vehicle. And so you see deposits leaving the banking system en masse, going into money market mutual funds and the like. Russ: Which put banks in great difficulty because they now didn't have the flow of funds they needed to pay off the promises they'd already made. GuestH: Right. This precipitates something that Charlie's written quite a lot about, which is the Savings and Loan Crisis of the 1980s, which is the death knell of the unit bank. We think of the S&L Crisis as being about Savings and Loans institutions, but it's also about lots of small banks which are heavily invested in real estate. And both the technological changes and the pressures that are put on banks by virtue of the fact that they are competing in a very difficult environment and now having to take big risks, precipitates--there's also a number of shocks--the S&L Crisis. And it's not until the resolution of the S&L Crisis that both state governments and the Federal government begins to seriously reconsider the wisdom of the unit banking system. Russ: [?] GuestC: It's interesting to compare and contrast the S&L Crisis's effect with the effect of the 1920s and 1930s which were also times when lots of banks were failing. And what's interesting is that I think if Henry Steagall and those people hadn't intervened, we'd already seen in the 1920s almost 20 states from 1920 until 1929 had relaxed their branch banking restrictions. And we saw exactly the same thing happening at the state level, from 1979 until the early 1990s. When banks get weakened and states start seeing a lot of banks failing, they start thinking, Well, maybe allowing a NationsBank to come in from another state might be worth doing. And then the FDIC (Federal Deposit Insurance Corporation) says, Well, that makes sense to us, too, because that could reduce our costs of having to support that failed bank. And so what's interesting is that didn't work in the 1920s and the 1930s. It got pushed back by Steagall. But in the 1980s and 1990s it did work. Part of the story is demographics--that there weren't as many people who were part of that agrarian coalition any more. Part of the story Steve mentioned is the ATMs and that Supreme Court decision. I think we can go into a lot of other elements. But one very important element was: the U.S. banks at this point, internationally, were getting globalization of finance beginning. And the U.S. banks are losing market share in the 1980s, not just outside the United States in international banking, but even within the United States. We're starting to see major entry. You may not remember this, that happened, but in the early 1980s, Japanese banks, German banks, British banks are entering the United States. It's starting to look like we're really going to become a bit player in the global drama of banking. And Alan Greenspan articulates this problem; and I think that many people are realizing that the United States, if it wants to continue being a global player [?] has to get serious about creating an efficient banking system. All these pieces are kind of coming together at the same time. And finally pushing us to a different outcome, which now of course is irreversible, because Federal law, in 1994 and branch banking, once it happens, you can't put the genie back in the bottle.

31:03

Russ: Let's move north and let's go to Canada. Tell us how different Canada's experience is from the United States. Charles, why don't you continue? What happened in Canada? GuestC: Well, first the most important thing to say about Canada is what didn't happen. Canada is a very boring place. Thank God. From a banking standpoint. Russ: First we slam the Post-Modern English professor who hardly knows how to invest unless we're in desperate straits, and now you are making fun of our-- GuestC: No, no, I'm not making fun. Sometimes boring is good. So, Canada never has a banking crisis. Russ: Ever. GuestC: Ever. In 1837 and 1839, some of the problems in the U.S. banking crises that were sweeping the whole country here created a couple of weeks of minor disruption in Canada. But no bank failures and no problems. So Canada has never had a banking crisis. This recent sub-prime turmoil didn't cause a crisis in Canada. The Great Depression didn't. The 1830s didn't. Russ: When you say it didn't cause a crisis--that's just that their banking industry weathered the Great Depression better than ours. They had virtually no failures? GuestC: No failures from any bank of any significance. And banks did fail. Small banks failed in Canada occasionally. Russ: Mismanagement. GuestC: Right. Another interesting thing is not only did they have no bank failures, but their total amount of credit relative to GDP (Gross Domestic Product) was either comparable to or better than the United States's during this history, despite the fact that they had lesser density of population and other things that might make you expect a very different outcome. So they had more abundant credit, more stable credit. And, by the way, analyses of how competitive the banking system is also show that it was more competitive. So it's really quite a remarkable difference. And I should mention also, probably-- Russ: [?] GuestC: Well, let me point something else out. Canada didn't even create a Central Bank, like a Federal Reserve System, until 1935. So it wasn't that it was a particular sort of wise central banking policy that explains it, either. They didn't have deposit insurance until much more recently than the United States. So it's really a story about a particular set of rules for engagement in Canada. Now, part of that, myself included, in the past people looked at this and said: Well, that's because Canada had nationwide branch banking; and of course that made it-- Russ: And hockey. GuestC: And hockey. But nationwide branch banking was much more efficient; much greater diversification of risk. All those things are true. But you know, as we've just learned in our own crisis, nationwide branch banking doesn't always give you stability. And so that's why we spend a lot of time in the book asking the question: What was it about Canada that made the political rules of the game in banking so successful? And when we dug deeply into that we found that there was a lot to be uncovered in the political history. Russ: [?] GuestC: I think that one of fundamental differences when you look at the basic Constitutional structure of Canada and the United States, is that the United States was founded as 13 independent colonies. Nobody imagines anything other than 13 sovereign states would be brought together in some kind of a union; and the debate in the 18th and 19th century is how strong the central government will be. In Canada, there is a basic geographical difference. All 13 colonies in the United States faced the seaboard, and so any one of them could trade directly with England. In Canada, the best agricultural lands and the timber resources are in the center of the country, in present-day Ontario. In order to get out to the sea you have to pass along the St. Lawrence river [sic--Seaway--Econlib Ed.], which goes through Quebec. We tend to forget it today, but at the time that the English pushed the French out of Canada, Canada is over 90% French-speaking. That creates a very difficult problem for the British colonists and for the British government, which is trying to create a viable colony out of Canada so that it doesn't meet the same fate the British colonies in the United States met. It's got to give sort of rights of suffrage to the population and at the same time it's got to limit the numerical power of the French in Quebec, who occupy a key geographic position along the St. Lawrence river, because right in front of the city of Montreal are the Lachine Rapids, which meant you had to build a canal around the rapids. But if the French wanted to hold up British commerce and development in the interior country, all they had to do is block canal development. And in fact, the British merchants in the interior of the country complained about this repeatedly. That means the long and the short of it--we spend a lot of time in the book talking about this, how basic geography drives institutions and those basic institutions then drive the banking system. That drives a centralization of bank chartering in Canada in the central government. This is in the 1860s when Canada is given sovereignty. It also drives a decision in Canada that all legislation, all authority not specifically given to the Provinces goes to the Central Government. Exactly the opposite of the United States, where all power is not vested in the central government by default of the states. It also at the time of the Dominion Act gives explicit rules that state that the central government will be in charge of banking policy. So right from the very beginning they go down a very different route from the United States. They go down that different route in large part for some geographic or geo-political reasons internal to Canada. And they then create a set of institutions that are designed to make sure that the French cannot block Canada's development. They essentially disenfranchise the French population. And the way they do this is in the Senate, which is an unelected--and is still an unelected--upper House. Initially Senators in Canada served for life. They now only serve till age 75. Russ: That's enough for government work. GuestC: And they still actually, unlike the British House of Lords, have veto power over legislation. And if you look at [?] of Canadian banking, there are key moments where legislation that would have for example created a step toward deposit insurance are blocked in the Senate. And key moments where there is sort of an impetus towards unit banking, and they are getting blocked in the Senate. In fact sort of every one of the populist waves that's happening in the United States, where banking issues are being brought to the fore, they are happening in parallel in Canada. The difference is that those groups lose in Canada because they can't cobble together enough political support within that centralized and sort of blocked political arrangement. But they win in the United States. And that to me is what is so interesting.

38:53

Russ: But this to me is one of the key insights of this book, and this whole approach. Economists have, I think, a tendency to see finance as--they see many things. Essentially it's just a mathematical problem, it's an engineering problem; we just have to figure out what the right incentives are. We just have to fix it. And they tend to ignore the political side. So, if you heard this story, you are thinking about it: Well, the United States has all these crises--bank runs, failures, disasters. Canada has this fabulous run of great success. Well, now we know what to do. Just be like Canada. Just give me your statutes and we'll just put those in place. And I think a lot of times economists make that mistake. They say, well, we know what the right solution is; we're going to advocate for that. And it's not just that it's "impractical" or it's too theoretical. They are missing what is fundamentally going on, and which you highlight in the book. So, Charles, explain why it is that we don't--you know, everybody wants a stable banking system, right? So why don't we just go to Canada and say, Okay, we'll just use theirs? Why doesn't that happen? GuestC: Well, as I was explaining to one person who asked me that, I said: How would you feel about the idea that we would have our Senators appointed by the Queen of England? Russ: That's a negative. GuestC: And that was inconceivable. And the reason it's inconceivable is, this is a country that was born from troublemakers, right? The yeoman farmers, armed to the teeth, from the very beginning who created a Revolution and weren't about to not be vested with authority in a particular way. But Canada is a country that was designed by people to avoid a Revolution. That created institutions that specifically made it the quintessential classical liberal democracy. Meaning, that it created all of these barriers to various kinds of special interests or even majoritarian tyranny. In fact, as Steve said, it's ironic that the United Kingdom, which gives up voting power over legislation in the House of Lords in 1911--Canada's Senate was modeled on that. But Canada's Senate persists! The House of Lords is pretty much emasculated in 1911. Russ: In England. GuestC: Yes. So what's so interesting is the whole history of Canada is a history of people trying to prevent certain bad things from happening: We've got to get Brits to migrate to Canada, so we have to give them enough democracy. But they are not going to migrate to Canada if the French are blocking everything, so we have to create democracy that is not going to be a French tyranny. Also, there are lots of--we want to get people to migrate from the United States to Canada; they had quite a few royalists leaving in the early 19th century to Canada. So it's an environment of people who are trying to find a way to have a democracy, to have freedom, but to still be within the British Empire.

41:58

Russ: That's a positive way to tell the story. Let me give the negative story. So, any reform of the U.S. financial system that takes large sums of money away from people who are already getting those large sums is not likely to be successful, barring some radical change in the political incentives. Do you agree, Steve? GuestH: I think there's always been a temptation, certainly since the 1970s in the United States, to look to the banking system as a vehicle for income redistribution off balance sheet. Russ: Yeah. [?] GuestH: Exactly. So rather than-- Russ: In the U.S. government. GuestH: Yeah. That temptation has been large for governments regardless of their ideological strife, and for parties regardless of their stated ideologies. That makes the--it's that basic problem, that no party really wants to give up on this. There are parts of the Republican Party that do. Russ: That say they do. GuestH: And I believe them. Okay? But that's not a winning coalition. The fundamental problem facing sort of you know facing the creation today a stable system of banking in the United States is that bank rules are arcane; hard for the public to understand. Coalitions can get created, designed to channel, to share the credit or to channel credit to particular groups--those rules are going to apply to everybody, because we're in a democracy, after all. And that's going to distort everybody's incentives--borrowers and bankers. The result is that the United States is set up, because of its long tradition of populism, set up to be crisis-prone. And it's I think a paradox in the United States. One of the things I admire most about the history of our country is the [?] history of troublemakers. Right? These were farmers who were willing to go toe-to-toe with the British army. That took a lot of guts. That didn't happen in Canada. One morning people woke up and they said, Oh, we're independent. What does that mean? Well, we will still have tea. So--independence when it occurred in Canada was something of a snore. They celebrate that they beat us in the War of 1812, not their independence from England. Right? That means that in the United States, precisely because we have this paradoxical history of populism which we simultaneously admire, but which generates this sort of use of the banking system for redistributive purposes--that creates this sort of urge by politicians to redistribute, rather than using the fiscal system, using the banking system. And because it occurs off the budget and because it occurs in a way that is very hard for the average person to understand, and because it is not--you don't have to pay for the bill until the banking crisis occurs and everyone needs a bailout, it's not seen. And so there's a very strong temptation to do this. GuestC: If I can just build on that briefly--one of the interesting things about the United States is that all of these checks and balances that we are all trained in, in grade school--what are we taught? Well, the United States is a liberal democracy, because we have all these checks and balances. But those checks and balances often do work to thwart fiscal policy to address issues like inequality. But then there is still a lot of freedom to do things in a hidden way. Off balance sheet. The support of the GSEs (Government-Sponsored Enterprises). Russ: Fannie Mae and Freddie Mac. GuestC: Right. Or the creation of regulation. Most people don't understand the arcane aspects of bank regulation, to understand what implicit transfers and taxes are involved in that regulation. So that means that if you are ideologically Republican representative who wouldn't want to be associated with a particular transfer, you are safe-- Russ: Because nobody knows it's happening. GuestC: Because nobody knows. And then you can do your deal in a hidden way. So, ironically, I think a lot of people that put faith in the checks and balances in the U.S. system are missing the fact that, particularly in the area of banking regulation, which is very big and very important, that that's an area where we have sort of addressed problems, especially inequality problems--instead of addressing them head on, we've addressed them in this very destructive way of using subsidies through the financial system, which tend to destabilize the system, as the way to do it. Even if you are looking at housing policy, Australia, which is unicameral legislature, is a country that has also been very stable in terms of its financial system. But Australia is in many ways a populist country. And Australia addresses issues of inequality directly, through fiscal policy. For example, what's affordable housing policy in Australia? It's giving down payments assistance to first-time homeowners. That, by the way, creates stability because it subsidizes more down payment. Which tends to stabilize the housing market. What we do is, because we have to do it through the back door, we do the only thing that we can do, which is subsidize instability, by subsidizing leverage. Russ: Yeah. GuestC: So, the point is, there are some flaws, I would say--I don't want to be too judgmental here, but there are some flaws in the way we address certain problems that kind of push us, as Steve was pointing out, in the direction of using this hidden stuff; and it's always coming through the financial arrangement. Russ: Just to echo that back: I find it remarkable how little we've learned from the Financial Crisis in terms of these back door, hidden subsidies. The Left has pushed back against any attempt to stop subsidizing mortgages; basically right now we have the Federal Reserve financing the mortgage market of the United States. This is not exactly what the founders of the Federal Reserve had in mind; it's not what most people would say is good economic policy. But it's politically very attractive to do that. And it's nuts--it seems to me.

48:38

Russ: But let's talk about the Crisis. Because I want to let you put your explanation on the table and then I do want to push back a little bit. You put a lot of stock, to my surprise, in the Community Reinvestment Act (CRA) and the Government-Sponsored Enterprises Fannie Mae and Freddie Mac. They certainly were part of the problem. But you don't talk much about the large private investment banks that issued private mortgage-backed securities (MBS), which were enormously a large part of the run-up in the early 2000s. And to me, without that we would have maybe an unpleasant system; we might have had Fannie Mae go broke. But a lot of the loans that were made were not made by loans that were under the Community Reinvestment Act. And it seems to me the moral hazard problem is a bigger problem as a cause. And to me the housing market is just the place it oozed out into. But it was something else. Defend yourself. Who wants to go first? GuestH: I'll start and Charlie will finish. I think it's important to get the chronology of the facts straight. As you mentioned, the private investment banks get in, in the early 2000s, into the MBS market. Russ: With two feet. GuestH: Oh, yeah. They see a market opportunity that Fannie and Freddie blazed for them going back to the 1992 GSE Act. That Act has several curious features. One of which was it told Fannie and Freddie that they had to repurchase loans from banks that met Affordable Housing standard criteria. Russ: They had to lend a lot of money to poor people, in bad neighborhoods that weren't getting-- GuestH: Up until 1992, total CRA lending is only $8.8 billion. A lot of agreements between activist groups and banks, but very little lending. Beginning in 1992--and incidentally this is legislation which is crafted under the first Bush Administration--be clear here; there is not a Democrat/Republican issue. The basic problem that the community groups have is they want to get access to more credit, channeled through their organizations to their constituents. Quite reasonably. That's their stated job. Russ: That's what they are trying to do. GuestH: Banks want to merge. In order to get approval for mergers. I think from the vantage point of today we don't have a sense of how rapid fire and dramatic these mergers are. Bank of America is essentially the amalgamation of 37 different banks in the 1990s. So in order to get approval for these mergers, they have to go before the Federal Reserve Board. Community activists show up at those merger hearings, and said that they can block them. And in fact community groups even write handbooks on how to block a merger. You can download them off the web. Banks backward induct, and they partner with the community groups and agree to channel credit through them. But they don't want to hold those loans if they don't have to. And they tell the community groups, the activist groups: There's a limit to what we are going to do. The activists, particularly ACORN but also the Neighborhood Assistance Corporation of America, go to Congress and they push. Particularly ACORN. And there are Senate hearings in 1991. So this is a full decade before the investment banks get in. This is a story that people like to tell, which is Fannie and Freddie followed private banks. Well, they followed in the sense that they are dragged in kicking and screaming into this deal. They don't want to buy these CRA loans that banks are making. The activists push in Congress to basically make them do it. And the thing that Fannie and Freddie extract in return is two crucial features. First, they are going to be subject to regulation not by the Fed; they are going to be subject to regulation by a unit of Housing and Urban Development (HUD). Russ: Their own regulator. GuestH: Their own regulator. Russ: It sounds bad. It's actually-- GuestH: worse than it is. It sounds bad and it's worse. Russ: Good [?] for them; bad for us. GuestH: Second, they are given capital requirements that are about 60% of--about 40% below those of--commercial banks. Russ: They are allowed to be highly leveraged. GuestH: Right. That means that Fannie and Freddie can get into the following business. You are a commercial bank; you sell me a loan. You had to put $4 in capital behind that loan while you held it, as a prudential reserve. I, as Fannie or Freddie, only have to $1.60 [?] in capital behind that same loan, because I have a different capital standard. If I now create a more mortgage-backed security out of a bunch of these loans that you sold me, that Charlie sold me and others have sold me, and put a guarantee on it--which I have to charge $.45 per $100 for--I can now create a mortgage-backed security essentially now being back by $1.60 in capital against the mortgage-backed security plus the $.45 for $2.05. And then sell it back to you. This creates tremendous incentive for me as a government GSE to be in the business of buying your bad loans and selling it back-- Russ: I understand-- GuestH: The banks only lead Fannie and Freddie in the extent that it's in their interest that Fannie and Freddie get into this business. Fannie and Freddie extract concessions. Later on, once this process is well underway, and once mortgage standards have been written, once this sort of basic game has been organized, that's when the investment banks get into the game. It is no accident that when the Crisis occurred, well over half and perhaps as much as two-thirds of all the toxic assets are sitting inside Fannie and Freddie. Russ: I don't know if that number is true. I know there is some controversy about it. The fact is, though, a lot of it is sitting inside privately-run, not-subject to the CRA, privately invested in highly leveraged investment banks like Bear Stearns and Lehman Brothers were, and some of it is even held by J.P. Morgan and Goldman--people treated it like [?] they stood aside; they didn't stay aside. They also were doing it. They didn't do it as much. They were a little more cautious. But hundreds of billions of dollars of mortgage-backed securities were packaged. They all had their own lending arms, originators. So, Charles, how do you explain their--let me ask it a different way: Okay, so Fannie and Freddie could have gone broke because they made a lot of bad loans under this political pressure we were talking about--which I think is true. And it would have been expensive. But to get a collapse of the shadow banking system to something else, it seems to me. GuestC: There are really two different issues here. Your first question was: Weren't there a lot of private players using their own money, these investment banks and Citigroup? Russ: Well, not their own money. GuestC: Well, their stockholders' money. Russ: Yeah. Kind of. GuestC: And the taxpayers' money. Both. Russ: Yeah, implicitly. GuestC: Weren't they also making some decisions here? So that's one question; I want to turn to that. Then there's a second question. The key thing to recognize is, if Fannie May and Freddie Mac were the 800 pound gorilla in the mortgage market and they were giving effectively what people regarded as a pretty good put option--in other words, they were the secondary market where mortgage-backed securities and mortgages could be dumped--this was especially important if you talked to people in the industry for explaining why there were so many violations of the various limitations on the portfolios that were being structured. Because as long as Fannie and Freddie were willing to give it a wink and a nod, it really didn't matter what the rules were because you knew you could sell these securities. The thing that people[?] didn't really know was the total amount of crappy stuff that was being originated. And the reason that they didn't know it was because there was no correct aggregation going on that you could turn to and figure it out. Only after we started seeing the default experiences in some of the categories of mortgages did we realize that they were effectively sub-prime quality. And the reason was, starting in 2004, the rise of the so-called Alt-A, non-documented mortgages. And we didn't really know how severe those risks were until we saw it starting in 2007. So people were actually very convinced; and that put option would have been good if there had only been half a trillion of these crappy mortgages. In fact, though, as we know from the SEC's (Security and Exchange Commission) settlement with Fannie and Freddie, they were holding $2 trillion of those mortgages. So that put option, as we know from having bailed them out was no longer good. So I think a lot of the explanation for why private parties were willing to engage in this so much was they didn't realize that that put option was going to disappear. The second explanation, of course, and we do get into this in the book, is that actually you are probably right. That is, there was other stuff going on. It wasn't all the story that we're telling. But we think that that's the dominant thrust of the story. There are other narratives out there having to do with monetary policy which we think also contributed. But we think that we wouldn't have had the two requirements to have a banking crisis, which are: Extreme risky assets that banks are holding, and tolerance for extreme leverage of the banks and the GSEs--if there hadn't been that political deal that underlay it all. And just one final sentence about this: the key thing is, Fannie and Freddie, when they relaxed their underwriting standards, they didn't relax it just in the affordable housing area. They relaxed them for everyone. Because they said: if we just relax them in this area, they couldn't have defended it. They had to pretend that they were not doing something imprudent. And that's what opened the floodgates for everyone.

59:14

Russ: I wish we could talk more about this, but we are almost out of time. So I want to try to sum up a little bit. Which is that--2008 was a really bad experience, for the United States and lots of countries. How much of that was due to bad social policy, expectations of creditor bailout--which I think was hugely important, which incentivized the investment banks and the GSEs and everybody to be imprudent with the money they were able to borrow, which they otherwise wouldn't have been able to borrow. We tried to fix it a little bit. Most economists think that our attempts to fix it have been a failure; that we are standing on the edge of another crisis in the next x years--we don't know what x is but things are not good. Where does that leave us? A cynic would say: Well, that's just the way it is; we just have to go from crisis to crisis. They seem to be accelerating, actually, worldwide. You have any reason for optimism? Or, do you have any hope for a different set of political incentives? Part of the theme of your book is: This is the way it is, folks; you may wish it were otherwise; you might have a better idea, but the political incentives don't let you do it. So it doesn't really matter. So that could lead to a very unrosy view of the future. But I don't think that's your view. So, one of you is an optimist and one of you is a pessimist. Which one's the pessimist? GuestH: I'm more pessimistic than Charlie. Russ: Okay, you go first, because I want to end on an optimistic note. GuestH: I want to be clear, however, the difference between optimism and pessimism is I say things that are pessimistic and Charlie says things that are pessimistic, but he smiles more while he says it. So, one of the reasons why we wrote this book is not just because we wanted to understand how things work. We wanted the public to understand how things work. And to be able to come away from reading this book with some heuristics for detecting when the financial system is heading off a cliff and they should start to become worried. Not just the public in general, but also financial journalists. And I would end here by saying if there's a lesson--there's two lessons the public could extract from this book. First, if you are counting on your elected representatives to be watching out for your financial interests as an average taxpayer, think again. The second is that any time a politician tells you that he's found a way to create a free lunch and that there's going to be this marvelous subsidy, and nobody is going to pay for it, reach for your wallet. Especially when that subsidy is coming through the banking [?]. Because what's going to happen is what happened in the years leading up to 2008. It's not that I think the CRA was a bad idea. It's that the logic of the CRA coupled to the mega-merger movement gave rise to incentives for Fannie and Freddie to lower their underwriting standards. And once that happened, they had to lower them for everybody. The whole society could pile into deals that literally were too good to be true. One of the reasons we wrote this book is to make it clear to the public: Any time a politician says, I have a deal that's too good to be true, or what Bill Clinton called 'the third way', it's time to get very nervous and think about voting for somebody else. Russ: And I would just add to that, that the push in the 1990s through both Republican and Democratic Administrations to raise the homeownership rate--[?]--'and it won't cost us anything.' Slightly overly optimistic. Russ: Charles, finish this off. GuestC: Well, I guess I would say, to try to end on an optimistic note, is: It is true we can't just throw away our institutions and history and constitutions and pretend that we are Canada, because that's not going to work. But what we can do is learn. And democracies do actually learn. Even very populist democracies. So, we've already mentioned, the United Kingdom for example became effectively a unicameral legislature, no separation between executive and the legislature, so we would say in some sense very populist. And particularly after WWII. And they nationalized all their industry[?] and they had extremely high tax rates. But that created some pressures on the economy. And in the 1970s and 1980s we saw extremely high inflation, very low growth; and guess what? It was unpopular. The rise of Margaret Thatcher was not just about Thatcher's leadership. It was about the fact that the median voter in that populist country was sick of it. And it's an interesting testament that the changes that were wrought under Thatcher were persistent and now are part of the mainstream status quo being endorsed by Edward Miliband and others. So I think the key thing is we're optimistic in the sense that we are spending a lot of effort hoping that the education of the people eventually leads to some sort of positive response. It's very hard in finance because it's very arcane. It's all too easy for politicians to give you the flim-flam. But let's be optimistic. Why not? Russ: More educated readers, who read your book, will be less susceptible to the flimflam.

1:05:05

Russ: Okay, we are going to open it to Q and A. And then we are going to have a little food and drink. Please when you are called on, identify yourself by name if you could. And use the microphone if you could. Audience1: I'm Arnold Kling. I'm trying to figure sort of what makes Canada's banks stable, and the thing that comes to mind is charter value, that the--you only have 5 of them, and they are profitable, and so they don't want to lose their charter, and so maybe that stabilizes things. First, I wonder if you agree with that. And secondly, if you do, what are the forces that keep that from happening in the United States? I think you mentioned the populist sentiment--people don't want banks to be profitable. The government wanted to use banks for redistribution purposes. Should we be trying to head toward a system where banks have valuable charters and if so, how could we head that way? GuestC: Okay, I'll take a first stab at it. So, first of all, I want to be very clear here. Banks have charter value for two reasons. One is because they run a business very well; and the other is because they are endowed with some monopoly, non-competitive rights. In the case of Canada, there is a lot of evidence that the second is not true, and has not been true. Despite the small number of large banks. By the way, of course there are thousands of banks in Canada, but there are only 5 that are very big. But the literature on competition among the banks has uniformly found that the banks are extremely competitive. But there is an element of importance to what is being limited in the chartering in Canada, and that is the exclusion of the Yankees. That is a very important part, we believe, of the bargain; and we aren't the first ones to point this out. Because, look at it this way. First, the Canadian Banking Act is re-made every 5 years. And the banks' charters expire every 5 years. Banks are on a fairly short leash in Canada in that sense. Also, part of the banking law effectively excludes U.S. banks and other foreign banks from competing on equal footing with the Canadian banks. So, we think that that is a system that's very conducive to the banks' also behaving well in the eyes of the regulator. And so long as the regulators act in the public interest, which it has consistently in Canada, that's also helping things. So, I actually think that the charter exclusion that actually matters in Canada is not one that is creating monopoly rents within the domestic system, but one that is creating a vested interest in the Canadian banks in not messing up their deal to exclude the American banks. Audience1: [?] a way to create some kind of charter value in the United States, or you don't think that's what you would? GuestC: I have a recent paper on looking at charter values of U.S. banks. And most of it is dictated by whether they know how to run certain businesses better than other banks. There's not really a lot of monopoly rent to be allocated. It's really about being able to do your business relatively, in certain areas, better than other banks.

1:08:54

Russ: Another question? Yeah. Audience2: Hi. Benjamin Kaye [?]. So, my question is: so, financial crises can be optimal in the sense that perhaps the cost of stopping them prevents real projects from being funded, positive NPD[? Maybe NDP, National Domestic Product?-- Econlib Ed.] projects from being funded. And so one thing that was not in the discussion from the last hour was basically what if any price in terms of the efficient allocation of capital does Canada pay for the decisions that they make in the industrial organization of their banking industry? Russ: Good question. GuestH: So, it's an interesting question and it creates a sort of technical problem because you would have to be able to model what Canada would look like if it had more expansive banking policies and therefore had sort of more volatility in credit. We can't observe that Canada. We can observe the Canada that does exist. And what has always struck me about Canada--that's an exaggeration; it hasn't always struck me about Canada; it struck me about Canada from the time I realized as a New Yorker that it was a separate country. What has struck me about Canada is the fact that this is a country with a very small swath of land that you can actually grow anything. You get 100 miles north of the border and it's too cold to actually grow anything. There are pockets of natural resources. Russ: Except hockey players. GuestH: Except hockey players. Right. Pockets of natural resources sprinkled here and there separated by vast distances. Nevertheless, Canada is a country with a tremendously high GDP (Gross Domestic Product), by world standards. And in fact has accomplished that even though it's mostly a primary-product producer, which means it's subject to big fluctuations in its terms of trade. A lot of that I think is due to the stability of the Canadian financial system. So I would be hard-pressed to make an argument that Canada could have done better had it had the U.S. financial system, which would have created much more volatility. They've done remarkably well given the resource base that they have. Just to give you a sense of this: the state of Iowa has more farmland suitable for growing corn and wheat than the entire country of Canada. So it's really remarkable what they've done, given the constraints they have. Russ: I want to just follow up on that question though, because I think it raises an important point that I wanted us to get to, which we didn't get to earlier. Which is: we have this obsession with never having any kind of crisis. And I think the right analogy is the forest fire analogy. So, forest fires are unpleasant. They are awful. Things die. It's not good. Your house can burn down. You can be killed. So there's a natural tendency to say forest fires are bad; we won't have any. When you do that what happens is that the kindling and tinder and other stuff, undergrowth, builds up to such an extent, because there's never a forest fire, that there eventually comes a fire that you can't put out. And it's so much work compared to having a lot of little fires. And that's what has happened with our financial system. We publicly say we are trying to find the perfect way to keep there from being any crises or distress. And as a result, it works really well--until it doesn't. And then we have the Yellowstone fire, which is unbearable, unpleasant, high-cost situation. And I think--Arnold Kling asked a good question, asked it the right way; I can't say it as well as Arnold, but we should have a system that, when it breaks we can cope with it rather than one that never breaks. [?] breaks can't happen, but we have this ideal that it can't happen, and it's a mistake.

1:12:57

Russ: Any other questions? Yeah. Audience3: Drew[?] Kennedy. So, one of the themes, I take it, from the earlier part of the book is that Federalism has not always functioned as a check and balance the way we think of it in that it prevents bad policies, but that sometimes it enables just other types of bad policies. And my question is: Do you think that's unique to finance, or as the country is continually debating national government versus states' rights types of issues, and health care and everything else--is that unique to finance or do you think this is a more generalizable issue? GuestC: It's a great question. I think that it's not unique to finance. But I think it may be somewhat related to how complex the issues are in the particular area. So, it's interesting to me that one thing that we also discovered was that monetary policy in Canada has also been better than in the United States. In terms of the inflation of the 1960s and 1970s, its level and its volatility, Canada also managed to have a better experience there. I think in trade policy you could also point to superior outcomes in Canada relative to the United States. So I'm not sure. I do think that there are these general kinds of issues that apply to other policy areas. But I want to take them one at a time. GuestH: I would add to that: I think that you bring question for political scientists to address. I don't think that there is a consensus answer to that question because the question has never been framed quite the way you put it. In most of the literature about Federalism it's all about market-preserving Federalism. Federalism is always good. There is this flip side of it, and I think it's been under-researched. So I think graduate students thinking about a dissertation project, this should be sort of a marvelous area to jump into.

1:15:14

Russ: One last question; anybody? Yeah. Audience4: [?] Tod Linberg. So, when my European friends and interlocutors say, this whole global economy mess is the fault of the United States of America, what is the short answer to that? GuestC: No, they have their own mess. Audience4: Well, I think-- GuestC: You wanted a short answer. The view that came out of this sort of boomerang thinking that everything is traceable to the U.S. subprime crisis is obviously wrong. And that the European problems have been brewing on their own for quite some time. But I think there is some truth to the idea that the United States has done more than its share to destabilize global finances over the last decades. Russ: And on that note, we'll adjourn.

The way that apparently different groups, with different political views, come together on an issue was very nicely brought out in the Bootlegger and the Baptist. This idea was brought up at the beginning of the Calomiris and Haber discussion, eg, how Acorn supported BoA mergers.

I also recommend that EconTalk fans listen to the podcasts with Bruce Bueno de Mesquita. They are the best explanations of why politics intrudes into the economic sphere in a less than optimal way. Those podcasts should be a core requirement for high school civics classes.

This podcast was awesome. These are men of immense understanding. They really did some impressive research.

The guests indicated that some truly non-democratic institutional leftover’s in Canada’s government—originally designed to undermine the democratic will of the French Majority—eventually served to protect all Canadians from attempts by interested parties to misappropriate the government’s monopoly-power for their own enrichment. This reminds me--in character at least--of Dr. Epstein’s comment on "Epstein on the Constitution" that efforts to maintain the legality of slavery in the US Constitution led to a period of unprecedented Freedom from central-government-compulsion for the rest of the population. Seems paradoxical, but I guess that is what Andrew Smart means when he calls the economy a “complex, non-linear system” in, “Autopilot”. It is just really hard to predict what outcome any input will produce, particularly way off in the future.

The guests really did not talk directly about the US Constitution or how it might be improved to slow or eliminate interested parties [majorities or motivated minorities] from hijacking the government to serve their own interests at the expense of everyone else. The discussion hinted that a lifetime appointment of a group of people with veto power over legislation might be a good start. Too bad the US Supreme Court doesn’t perform that function…

I am most impressed with Mr. Calomiris and Mr. Habers’ assertion that the Rules-of-the-game and the Laws-of-the-land are products of the environment; including history, climate, local power players, national and international influences, competition, geography, etc. They implied that it is not wise to assume that laws and practices that were successful in one country would necessarily succeed in another since the environmental assumptions are different. Brilliant. Truly.

I find their stated goal of educating the public eminently practical. It lines up very nicely with Dr. Roberts stated goals with Econtalk. The Hoover institution continues to impress me with the quality of its members.

In that vein, I think it is important from an educational perspective to point out that anywhere in the guest’s historical accounts where competition was restricted, bad things happened. Competition is your friend.

Finally, I thought Russ’s statement during the question & answer session that frequent small adjustments in the economy are preferable to infrequent catastrophic ones was right-on.

I think Charles Calomiris claimed Australia is a unicameral legislature, which in fact has a bicameral legislature. Calomiris might have been mistaking New Zealand, which does have a unicameral legislature.

Also, he is right about the policy of providing subsidies to first home buyers, although I am not convinced that intervention is a stabilizing force as he claims.

Great interview - one observation based on a comment by the authors that they believe that the first home owners grant in Australia is a way to subsidize housing that creates stability in the housing market.

This is not my observation. What happened on the ground was the first home owners grant tended to be leveraged because this is the nature of housing finance in Australia. So if the first home owner got a $10K subsidy and the bank required a 20% deposit then the additional $10K allowed the buyer to borrow an additional $40K over what they would have been able to afford before the subsidy. This extra buying power drove up prices.

Moreover there were second order effects - in this example, say the seller got $40K more than they would have got if there was no housing grant, this $40K could be leveraged up to $160K.

Australia's First Home Owners Grant makes little impact with Australian stamp duty which is considerably more than the First Home Owners Grant.

Australia's housing market is also quite strange. In the 1990s prices were comparable and cheaper in some places than the US. Now the average Australian home is about 500K USD and income to valuation rates are some of the in the world.

GREAT podcast on a very significant issue (I've followed this on econ talk for several years). I agree that the private banks took their own risks, knowing they would be bailed out (campaign contributions have a point), but Fannie and Freddie were definitely in the middle.

Amazing Baptists and Bootleggers example.

Now, I have even more reasons to migrate, as I don't want to be the taxpayer sucker who pays for DC/Wall Street "populist" scams.

Russ tried to reconcile this take with some of his others, but net net, I think your average guest would be surprised to know many of your guests have profound disagreements. I think he should try harder to identify the essence of the very different emphasis applied to the 2008 crisis; everyone can't be 'basically right.'

As part of the ongoing discussion of the 2008 crisis this is just another set of data points, hypotheses, and conclusions. Whether or not this book explains anything at all better than other theories out there or shifts where our conclusions should end up requires far more than an hour's presentation at a book launch. I do think the venue and setting allowed for less pushback than a proper interview, but since I have, and I suspect many others have, listened to every episode of econ talk on the topic the soft reminders were sufficient to bring up the counter points from memory.

As an aside, does anyone know if there is an audiobook version of this book in the making?

An interesting podcast for the first half but I found that the writers were trying to create a far too pat answer on the question of why the financial collapse occurred.

Of course the GSEs played a significant role in the housing collapse. But their attempt to brush off the impact of the capital markets to securitize that debt in a way that removed risk seems truly baffling to me.

It seemed to me that they wanted to tell a specific story, which had some merit, and simply discarded the other parts of the problem(highly leveraged investment banks, credit rating agencies being gamed, reserve requirements of commercial banks being far too low, etc) because none of those aspects served to further their narrative of politics and government distorting the market.

I found it particularly troubling when they made the claim that almost 2/3rds of bad debt was held by the GSEs. I have not read that ANYWHERE and I find that number to be highly specious. The GSEs are not able to buy "bad debt". They can only buy conforming debt. Now it is true that the standards for a conforming debt were loosened by the CRA and some other political actions, but very little of the conforming debt was the problem until well after the housing collapse was in full gear and the relatively good loans became bad as a correlation to the bad debt going belly up.

Furthermore the writers completely ignore the fact that a large portion of the dad debt was in fact refinancing and 2nd mortgage loans, which had nothing to do with GSE guarantees.

Now where the GSE were a big problem was on the capital markets side where they were one of the largest buyers of toxic capital instruments such as the CDOs. But that does not exonerate the investment banks and their role.

The suggested causes of the recent US housing don't make a lot of sense to me. The discussion focuses initially on unit banking, but unit banking is long gone by the time of the recent crisis. The authors describe the hidden transfers as being rooted in populism. However, how can politicians expect to directly gain votes by influencing those rules if, as the authors suggest, voters can't recognize or understand the impacts of banking rules? Finally, Canada is held up as an example, but if their "Banking Act is remade every five years", doesn't that potentially give Canadian politicians more power over banks than in the US? If so, wouldn't that make the Canadian system much more subject to populist pressure, if populism does in fact have a substantial impact on banking rules?

Isn't it likely that campaign contributions have much more of an effect on banking rules than voters directly, and that differences in the campaign finance systems between the US and Canada explain more of Canada's success?

It's a good idea to take with a grain of salt anything Paul Krugman says about Fannie and Freddie's role in the housing bubble. He's already had to admit he was wrong to claim they were barred from participating in the subprime markets.

More specifically, both FMs agreed, in litigation with the SEC that they'd misrepresented their portfolios. Which vindicates Peter Wallison, Ed Pinto's (and Calomiris) analysis of the extent of their holdings. As the SEC's press release put it;

The Securities and Exchange Commission today charged six former top executives of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) with securities fraud, alleging they knew and approved of misleading statements claiming the companies had minimal holdings of higher-risk mortgage loans, including subprime loans.

Later spelling out the charges;

...when Fannie Mae began reporting its exposure to subprime loans in 2007, it broadly described the loans as those "made to borrowers with weaker credit histories," and then reported — with the knowledge, support, and approval of Mudd, Dallavecchia, and Lund — less than one-tenth of its loans that met that description. Fannie Mae reported that its 2006 year-end Single Family exposure to subprime loans was just 0.2 percent, or approximately $4.8 billion, of its Single Family loan portfolio. Investors were not told that in calculating the Company's reported exposure to subprime loans, Fannie Mae did not include loan products specifically targeted by Fannie Mae towards borrowers with weaker credit histories, including more than $43 billion of Expanded Approval, or "EA" loans.

Fannie Mae's executives also knew and approved of the decision to underreport Fannie Mae's Alt-A loan exposure, the SEC alleged. Fannie Mae disclosed that its March 31, 2007 exposure to Alt-A loans was 11 percent of its portfolio of Single Family loans. In reality, Fannie Mae's Alt-A exposure at that time was approximately 18 percent of its Single Family loan holdings.

The misleading disclosures were made as Fannie Mae's executives were seeking to increase the Company's market share through increased purchases of subprime and Alt-A loans, and gave false comfort to investors about the extent of Fannie Mae's exposure to high-risk loans, the SEC alleged.

Despite having more moving parts(two guests and live) than the typical EconTalk, I really think this format worked well. The two guests worked were always in sync and easy to follow.

Substantively, I'm wondering why banks didn't (or weren't allowed to) merge or move across state lines in the 1800s? I understand that it was the political role of states and the political power of the agrarian lobby that may have made this happen, but couldn't this have been challenged constitutionally? Wouldn't the state-enforced banking regulations amounted to a tariff barrier? This is (was) one of the things that the federal government is (was) properly charged with in the Constitution. So why was there no challenge to this? Were there technological considerations that made it difficult?

It would seem to me that an interesting legal test case of this would have been a bank operating in Cincinnati, OH wanting to open a bank across the river in Covington, KY.

And what about Wells Fargo? I seem to have this image of it as being that bank that moved with wagon trains to settle the west and dropped lots of different bank branches along the way.

Before the end of 2014, I think I will tell you now that this was my favourite episode. Despite some odd sounds, which I assume were from the live recording, this was my favourite episode in the last 6 years of listening. I will be listening to this podcast again, and buying this book.
The question and answer was a great addition to the talk, though obviously not possible when it is not recorded live. But the thing that made this podcast stand out so much more, was the time allocation discussing Canada. I assume you have many listeners not in the U.S., as I have shown this podcast to many in Europe and Canada (Canadian living in Europe). And when guests discuss other nations either directly or relative to the U.S. it makes for an extremely interesting interview.
So, as a self-appointed representative for Canada, allow me to thank you and your guests for the excellent talk and background on Canadian banking.
Best regards,
Robert

Very good podcast, and as I listener I enjoyed the live format followed by Q&A.

"Fragile By Design" is a very appropriate book title.

One point of criticism: I am skeptical of the claim of the CRA's importance. Clearly, it played a role, as a sort of tool to facilitate the mergers and to lead to some of the regulatory mess. But was it an essential role?

Obviously, the risky activities that led to the crisis were highly profitable (financially and politically) for the players involved... until they weren't. And CRA was leveraged in various ways to attain those profits.

But had CRA not been available, would there have been no crisis? Or would the players have found other regulations to leverage for the same effect? "Bailout math" would still have been in play, after all.

The major point is that the government is dysfunctional because it is too influenced by special interests. I strongly agree.

Some of their examples are laughable except that they are taken seriously by others. CRA, Barney Frank and ACORN were not major contributors to the crisis. To think they had enough influence to do so is ridiculous. Frank was not chair of financial services from 1993-2006 because the Democrats were in the minority. The major banks were throwing a few crumbs to community groups to get their support for mergers.

Russ has a much better discussion of the causes of the crisis elsewhere. I'm puzzled, and disappointed, that he didn't challenge the assertions made on this podcast.

The GSEs were engaging in capital markets investment by buying deriatives of subprime mortgages.

That what the GSE Act of 1992 forced them to do?

My reading of it is that the FMs were ordered to meet quotas of 'affordable' housing loans. Quotas that increased almost every year thereafter.

It was only AFTER the FMs showed the way that private investment banks got involved. The accounting scandals of 2003-04 at the FMs gave an opportunity to take business away from them, but Fannie and Freddie regrouped (with a vengeance) afterwards.

CRA, Barney Frank and ACORN were not major contributors to the crisis.

Then why did Barney Frank apologize for the role he played?

The CRA passed in 1977. Using that authority, Wm. Proxmire and Alan Cranston in the Senate, and Patricia Robert Harris at HUD, pressured the FMs into agreeing to make more loans to low income borrowers. The initial 'voluntary' agreement was 30%.

Partly as a result of that political pressure, the FMs got into the business of buying MBS from other institutions, because they needed the income from the fees they earned by doing so--thanks to their implicit government backing, they could borrow in the markets at lower interest rates.

And, as a result their foreclosure rates began to rise alarmingly. Fannie's nearly tripled from .42 in 1981 to 1.16% by 1986. Fannie was the nation's second largest borrower by this time, behind only the Treasury. It beggars belief that this '800 lb. gorilla' wouldn't have been at the center of a housing bubble/crisis.

I was a student of Dr. Calomiris at the University of Illinois in the early 1990s and was pleased to hear him again on this podcast. What I heard is consistent with what I remember -- someone with a passionate interest in the history of banking who because of that passion can even make the subject of bank regulation engaging.

The CRA pushed commercial banks to provide more loans to lower income people. Part of how they did that was to loosen the standards for conforming loans.

However, conforming loans, even at the looser standards of the 90s and 2000s, had little impact on the financial crisis.

It was sub prime borrowers that led to NON-conforming loans were the problem. And the fact that those loans were packaged in such a way that the risk was clouded was the problem. And the GSEs investing those loan packages, in order to generate greater profits, was the problem.

You are puzzled and disappointed that I didn't challenge the assertions made by the two guests. But I did--I suggested their story was an ex post narrative, that they had overstated the role of the housing policy as a cause rather than an effect and that they had ignored the role of the investment banks who were not covered by the CRA or the GSE's affordability mandates.

I see your job as the listener is to decide whether their responses to those challenges is convincing. Sometimes I do follow up and press a point, but sometimes I don't have time given that there are many other ideas that I want you to hear as well.

I don't follow your point. I'm not defending the GSEs. They made serious errors. What I'm saying is that the CRA was more or less irrelevant when it came to the financial collapse because the loosened standards for conforming loans had almost no impact on the housing collapse.

It is difference between public policy driven errors and market driven errors.

Russ,

You were skeptical of their claims about the GSEs but I think you were more soft shoe in your critiques of them than you would have been had they been more liberal. But that isn't exactly a horrible flaw.

I find it incredibly annoying that conversations on this topic routinely devolve into "government bad" vs "business bad". The only thing more laughable than the idea that a single causative factor could be found in such a complex system is the idea that "government" is different than "business". Each, at their most basic, is a system of rules in which actors pursue what they perceive to their best interests. What is a "market" if not a set of rules enforced by guys with guns? I'm looking in your direction Brian G and Patrick R. Sullivan.

Brian, the CRA is the sine qua non of the financial crisis. It's the nail in the story we all learned as children that begins; 'For want of a nail, a shoe was lost...' That one ended in catastrophe too.

How would we have had the crisis without loosening the lending standards?

Christian, you'd do better to look in your own direction. Or maybe use this website to read 'The Calculus of Consent', where you'd find that business and government have different incentive structures.

I can't remember another EconTalk episode with more to like and also more to criticize.

I thought the survey of banking history was superb. Ditto for the concise and convincing explanation of why banks and governments are inevitably intertwined. That alone was enough to make me buy the book.

Like many other commenters I found the weight given to CRA as a prime cause of the financial crisis to be preposterous. I assure you I have no love for CRA. I have been an outside director at a small community bank for the last 15 years. CRA is an expensive and unnecessary hassle and should be repealed. It is a prime example of a government program that has long outlived any usefulness it may have once had but refuses to die. That doesn't make it a significant cause of the financial crisis. During my entire tenure as a director we have never failed a CRA exam and never once originated a single bad loan due to CRA.

The key fact to consider here is that the GSE's loaded up on vastly more subprime loans than they needed to satisfy CRA requirements. When you get a speeding ticket for going 100 miles an hour on the interstate it won't work to blame it on the fact there was a 45 mph minimum speed.

Why did the executives of these companies choose to load up on this risky debt? Because, until they blew up, subprime loans were the most profitable loans. And at both the GSE's and the private investment banks, executives were hired, fired and compensated based on short term results. Risky debt was the easiest way to make a quick short term profit. They didn't take on so much subprime because they were forced to. They did it because they wanted to.

Executives at these companies could and did make tens of millions of dollars a year by playing this game. After just a few years they would be set for life whether or not their companies blew up and whether or not their companies were bailed out.

We are constantly told here that incentives matter. And they do. But it seems that interest sometimes wanes in those perverse incentives that cannot be blamed on government.

Calomiris and Haber did a good job of contrasting American and Canadian banking. But any analysis that purports to discuss relevant international comparisons needs to address why there were spectacular housing bubbles and financial crises in several European counties that lacked CRA or GSE's comparable with Fannie and Freddie.

What you will find in those countries is a similar system of spectacularly high executive compensation for delivering short term profits while taking on long term debt.

"Brian, the CRA is the sine qua non of the financial crisis. It's the nail in the story we all learned as children that begins; 'For want of a nail, a shoe was lost...' That one ended in catastrophe too.

How would we have had the crisis without loosening the lending standards?"

There's a truck sized gap in your logic.

It's clear that the government players and the quasi-government players and the private sector players all gained tremendously (*in the short term*) from the housing bubble.

If this wasn't true, they wouldn't have done it. CRA or no CRA, if the government wanted to put a stop to this activity, they could have done so. They didn't. There was strong bipartisan consensus to ride this train - no one wanted to get off.

The private sector, for a time, made huge financial profits. Individuals at the firms involved received huge bonuses that were not repaid. CRA or no CRA, they got involved because there was huge money in it for them, and perhaps because they thought that the government had their back.

Everone seems to be missing the point; banks were refusing to make the kinds of loans that blew up in all our faces (eventually). It took the CRA, followed by the 1992 GSE Act, the HUD Best Practices Initiative, etc. to get the reduced quality loans to be made.

The govt. complained that banks were 'redlining', keeping the poor from owning homes. It wasn't the banks idea to make those loans. You can read articles in banking journals in the 1990s by bankers complaining about the pressure the govt. was putting on them. Making loans that won't be repaid is bad business.

It is you who is missing the point. You don't have to pressure someone in order to get them to do something they want to do.

Taking bankers complaints at face value is a really bad idea. Bankers always complain about government - sometimes with justification and often because it is more convenient than taking responsibility for their own mistakes. When is the last time you heard a banker admit that his bank blew up due to his own bad management? Has that ever happened?

Banking standards have indeed sharply declined since the early 90's. That is true. They did not decline because bank executives were forced by government to make bad loans. They declined because executive compensation got so excessive and so closely tied to short term results that bank executives profited immensely from making these loans. Before they blew up subprime loans were the bank's most profitable loans.

That is exactly why the private investment banks got caught up in this mess. They were never subject to CRA. These loans only had to pay for a few years to make the executives rich. They got to keep their compensation whether or not the loans later went bad and whether or not their banks were bailed out.

This is the only explanation that addresses why the GSE's bought much, much more subprime than any regulator ever required. And it is the only explanation that addresses why financial companies not subject to CRA went into subprime so enthusiastically.

The narrative that the financial crash was caused by low income people using their vast political power to push around helpless bankers is really pathetic.

Sheila Bair, former head of the FDIC, said that the CRA had no meaningful impact on the financial collapse. She pointed out that only 25% of the loans to subprime customers were given by CRA covered banks. IOW, 75% of loans were made by companies that were not required to comply with the CRA in any way.

The problem were subprime and alt a loans which were being given out like candy. And they were given out because the capital markets had wrongly packaged these highly risky loans as low risk loans.

There is a desire by some to blame the CRA because it is convenient ideologically. If you are a free market kinda guy, the CRA is a useful bogeyman because it can be used to blame the government and exonerate the market.

However, as usual, the convenient bogeyman is rarely the true culprit. The government, actually several governments, did make big mistakes but mostly in the area of failed regulatory oversight.

You are simply not accurate in your assessment. The UAG goals had little to no impact.

http://www.federalreserve.gov/pubs/feds/2012/201225/201225abs.html

". The results suggest a small UAG effect and challenge the view that the goals caused the GSEs to supply substantially more credit to high-risk borrowers than they otherwise would have supplied. Although the goals may have spurred the GSEs to purchase more multi-family mortgages and REMICs than they otherwise would have, my analyses suggest that the GSEs' purchases of whole single-family mortgages to satisfy the goals did not drive the subprime lending boom of 2002-2006."

Fannie and Freddie wrote the book on regulatory capture. No one was better connected to both political parties than they were. Of course they complained that the regulations were onerous. That tactic is straight from Regulatory Capture 101.

The idea that they were bullied by ACORN and "scrambling" to satisfy their regulators "every year" is preposterous. Fannie and Freddie had the most effective lobbyists in a town full of effective lobbyists. That is why their support ran so deep in both political parties.

'The results suggest a small UAG effect and challenge the view that the goals caused the GSEs to supply substantially more credit to high-risk borrowers than they otherwise would have supplied. Although the goals may have spurred the GSEs to purchase more multi-family mortgages and REMICs than they otherwise would have, my analyses suggest that the GSEs' purchases of whole single-family mortgages to satisfy the goals did not drive the subprime lending boom of 2002-2006.'

Note the time period discussed; 2002-2006. The game was well underway by the late 90s. Your source is just another Housing Cause Denialist, and not a very clever one.

Every now and then, you hit a home run with the podcast, and in my opinion, this was one of those times. A superb podcast (I already want to listen to it again), and I can't wait to read "Fragile By Design". Audio quality aside, this one was great!

Thank you Russ for this great podcast. It is good to have experts like Calomiris and Haber talking about the bright side of financial connectivity due to branch banking in Canada vs the US. Since the conventional view that has emerged in the aftermath of the 2008 financial crisis is that the US and other financial systems are "Too connected to fail" (See Battiston et al http://www.nber.org/papers/w15611 for instance). If Canada has a more connected financial system relative to the US then, why did it not experience the same fragility? It is a question that remains to be answered. Besides the conclusion that highly connected financial systems have a higher probability of systemic risk, it is not different from the older argument that financial systems with outsized banks are prone to fail 'cause they're too big ("too big to fail" type of arguments). Then, the real question is: what are the factors causing too big or too connected banks in any financial system? It could be that legislations such as CRA or banking systems used for redistributive purposes are the underlying causes of financial connectivity beyond the "optimal threshold" mentioned in the papers like Battiston et al., so regulation not just market forces increased connectivity yet this line of research does not recognize this.

The broadcast sidestepped the problem of perverse incentives. Suppose hospital patients pay drivers not to honk their horns outside in a free market (ignore transaction cost), motorists now have an incentive to drive up and down in front of the hospital to collect payments for not honking. When the cost of payments exceeds the harm they cause patients stop paying and those who actually wish to drive past and honk resume the practice. The only way to achieve the optimal - no honking - state is through regulation but the Coasian regulation would allow it.
Also the general bias in favor of victims over perpetrators is justified by the certainty of the victim's loss but the uncertainty of the perpetrator's if his actions are prohibited. We do not know if the motorists wanted to honk or to drive past at all but we do know that the victims suffer when they do; so a discount is applied to the perpetrator's claimed loss.

It sounded to me like the authors explained Canada's immunity from the bugaboo "populism" (and conversely, the US system's frequent reliance on "hidden," "indirect" policy mechanisms) by virtue of the fact that the basic/overt mechanics of one of these systems "work" well enough for enough of its participants so that the "populist" urge never reaches critical mass -- while in the other system, they don't -- and the levers for reforming those overt mechanisms are similarly broken. The authors argue persuasively that Canada's relative stability is largely attributable to broad structural/historical factors that have little if anything to do with the individual behavior or ethics of present-day Canadians... Perhaps I missed something, but the overall podcast left me with the distinct impression that the authors took the opposite approach to explaining outcomes (or the structures that inexorably give rise to outcomes) in the US...?

"Audience3: Drew[?] Kennedy. So, one of the themes, I take it, from the earlier part of the book is that Federalism has not always functioned as a check and balance the way we think of it in that it prevents bad policies, but that sometimes it enables just other types of bad policies. And my question is: Do you think that's unique to finance, or as the country is continually debating national government versus states' rights types of issues, and health care and everything else--is that unique to finance or do you think this is a more generalizable issue?"

In light of the whole discussion maybe this is the wrong way to look at healthcare issue (one of the examples Drew Kennedy uses) or many other laws. The recent healthcare law is a law dealing with the finance of healthcare and was very much driven by subsidizing various groups off -balance sheet and on the backs of the non-subsidized groups.

This sounds very much like the other financial regulations discussed in the show- off-balance sheet subsidies. I would ask the question this way- how many other laws that are currently being written are that subsidize various citizens while keeping the costs off-balance sheet and on someone else's dime as opposed to having all the citizens pay for the cost? Another one that comes to mind is rent control.

There is a "fish aware of water?"element to the discussion. That fractional reserve banking is a good idea. That usury,contrary to eons of tradition, can work without a surplus of cheap energy.
The basic conditions of banking are threatened by the decreasing return of energy per unit of energy invested. This makes the usual frauds and larcenies more obvious. The real pie is shrinking, the virtual pie,measured in digital dollars, will go poof!

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